March 21, 2022

Demystifying Terms - Part 1: Valuation, Dilution, Anti-dilution and Liquidation Preferences

A first of a three-part series where I summarise my learnings and break down the key terms you need to understand and apply

Amanda Hjorring

October 18, 2021

Demystifying Terms - Part 1: Valuation, Dilution, Anti-dilution and Liquidation Preferences

A first of a three-part series where I summarise my learnings and break down the key terms you need to understand and apply

Amanda Hjorring

Over the past seven years, I’ve helped to negotiate hundreds, if not thousands, of term sheets with companies including Canva, Airwallex, Stashaway, Fiverr and many, many more. We're lucky to work with founders across Australia, Southeast Asia and Israel, and this global perspective means we have developed a unique insight into what matters to founders and investors globally.

The following article is the first of a three-part series where I summarise my learnings and break down the key terms you need to understand and apply as a founder.

If you are a founder looking to partner with investors, this is my advice to you.

Why do term sheets matter?

A term sheet is one of the most important documents you will sign when you are fundraising. It sets out the key terms that will form the building blocks of your relationship with your investors. We encourage all founders to use industry-standardpre-money term sheets, and to resist including unusual or exotic terms for investors. Just as your business needs to scale, so too will your legal agreements; complicated term sheets can cause problems in later fundraising rounds and are best avoided. One such example we use often is the AIC’s term sheet. The NVCA's model term sheet is also very useful.

You will be building a long-term relationship with your investors, so think of the term sheet as the pre-nuptial to the partnership.

It’s vital that you and your investors are on the same page from the outset, and the term sheet is the perfect tool to nut out philosophy and alignment between the company and the investor.

We have seen hundreds of term sheets and they come in many shapes and sizes, but when you boil it down, the key terms address either economics or control. It is all about dividing up the upside and the risk between the parties. And, although there are nuances between the geographies we invest in, Australia, SEA and Israel, generally the terms are similar and follow what we see in the US. One difference we commonly see in SEA is the inclusion of a redemption right. We advise founders to avoid these if they can!

We will address economics here, cover control in Part Two and go into detail on particularly difficult clauses in Part Three.

And before we start, remember that negotiating a term sheet is a key milestone in your company’s journey and a fantastic opportunity to understand who your investor is.


Economics are arguably the most important part of the term sheet. After all, you are trading partial ownership in and control of your dream, for growth capital, and hopefully gaining a valuable long-term partner.


Let’s cover the basics first, pre money valuation, post-money valuation and dilution.

You will often see a term like, Square Peg will invest $10m for a 10% interest in the target company. To determine the post-money valuation or the value of the company post investing $10m, you divide $10m by 10% to get $100m.

The pre-money valuation is the post-money valuation less the new money invested in the target company. In this case, $100m less $10m equals $90m. Simple! However, if the terms also mention a top-up to the employee option or share plan (ESOP), this may also affect the pre-money valuation. This is important to understand as new money and top up to ESOP dilutes the existing investors shareholding, and most importantly the founder’s ownership.


Dilution is the change in your ownership due to new investment, or the issuance of new shares. In the example above, the new investor is getting 10% of the company, so your ownership will reduce by 10%. So, if your % ownership is 50%, your post-dilution ownership is 45%, being 50% x (100% - 10%). Easy!

Now let’s introduce ESOP. What if the terms say, ESOP available to be issued to staff must be at least 10% of the post-money shareholding? The key thing to understand here is whether the ESOP top-up is to be issued pre-money or post-money. A good term sheet should state its intention clearly, which is usually pre-money.

To make things simple, let's assume that there is no ESOP, and that 10% of shares need to be put aside for staff incentives. In the example above, the dilution from the new money was 10%. If you add the dilution due to the ESOP, the dilution to the existing investors is 20%, 10% due to the new money plus 10% for the ESOP. This means that the founders 50% ownership dilutes to 40% instead of 45% (50% x (100% - 20%)). Although nobody enjoys their shareholding being diluted, least of all founders, the company receiving new investment and being able to attract quality staff are key to building a valuable business, so this is almost always worth it. After all, a smaller slice of a large pie is usually better for everyone. However, it is important that you understand the terms and how they affect you before you sign on the dotted line.

We’ll cover more on ESOP in part two, including size of ESOP, how to size the ESOP pool and why it’s so important.


Anti-dilution provides investors protection when a future financing is done at a lower valuation. The three main types of anti-dilution are “broad-based weighted average”, “narrow-based weighted average” and “full ratchet”. Broad-based weighted average is the most the founder friendly and is commonly seen today, and in fact, the only method I have seen in Square Peg investments. There is lots of literature on the different methods of anti-dilution and how they are calculated, so we won’t cover this here. Cooley GO and Holloway are great places to start.

Founders and other common shareholders don’t like anti-dilution, as it dilutes their holdings if invoked. That said, it is very rare not to see anti-dilution clauses in companies post series A, so my advice is, if it really matters to you give it your best shot to exclude it but expect investors to insist on it. From the investors point of view, they are usually investing at a valuation that reflects future growth and so if that doesn’t eventuate and a future round is at a lower valuation, they want some protection. If you do agree to anti-dilution provisions, founders should insist on broad-based weighted average, as it is the most founder friendly.

Of course, the win win scenario for everyone is where a company continues to grow and anti-dilution becomes irrelevant.

Liquidation Preferences:

Preferences are rules on how the proceeds of a sale or other liquidation are divided between the shareholders. If all investors hold ordinary or common shares, each investor receives the same per-share amount when a liquidation event occurs. This is often seen in later-stage companies that are about to IPO. In earlier stage companies, preference shares are always a feature.

A preference share usually has a right to receive proceeds in an exit ahead of common shares. There are various types of preference shares, so founders beware. The most common preference seen in today’s market is “1 times non participating”. Steer clear of a term sheet that has a participation but if you have to sign one, make sure you understand how the proceeds are divided upon exits!

“Non-participating” means that the holder of the preference share gets, ahead of other investors, the greater of: (a) “x” times your amount invested and (b) your % holding multiplied by the exit proceeds. As mentioned, “1 times” is usual in today’s market.

“Participating” means that you get back your amount invested plus your % holding multiplied by the remainder of the exit proceeds, leaving less for the balance of the investors to share in. Participating liquidation preference are sometimes referred to as “double dipping”, because in addition to receiving their investment amount, the holder also receives a pro-rata share of the remaining proceeds of a sale.

Although this may all seem common sense, especially if you have had experience raising capital, it is not unusual to find a founder that hadn’t realised what they signed up to. A good partner should make sure the terms are clear and check that you understand what you are agreeing to. Always ask if you don’t understand the purpose of a term. If the response is “this is industry standard” push the investor to explain why. Usually, terms are logical and are included to encourage alignment but don’t be afraid to ask if something doesn’t make sense. Finally, there are lots of great resources on terms. I’ve added some useful links to some of these below.

Go to Part Two: Repurchase Agreements and Founder Vesting.

If this article has helped you get a grasp on the important terms you can subscribe to All Signal, where we share long-form content and insights. And, if you’re inspired to learn more, I recommend reading venture capital deal terms and Venture Deals.